Knowing Is Half the Battle

Asymmetric information is a phrase economists use to describe scenarios when one party has more information than another. Examples are abound: actors know more about the quality of movie they're selling than movie goers; workers know more about how they spend their time than their bosses; borrowers know better than banks how likely they will pay back the loan.

One of the problems that erupt in asymmetric information is adverse selection: when someone chooses something that started off being a bad idea, such as eating a sandwich that the waiter dropped on the floor. But because the customer doesn't have the same information the waiter does, they take a bite. Hence the name--people will select something that isn't in their interest to select.

Many of my students, however, read this as when people choose things that are bad for them, such as driving drunk or smoking. In this latest homework assignment, people would even mention "everyone knows that such and such is bad for you." Then it's not asymmetric information and adverse selection doesn't apply. If you know smoking's bad for you and you still smoke, you are including the health risk as a cost. People might regret this choice later in life, but it's still not adverse selection. Just because you don't agree with their choice doesn't mean its a problem.

The other major issue from asymmetric information appears after the choice is made: moral hazard. When people make an agreement and then one of them figures they can take the other for a ride, that's moral hazard. There's an element of treachery here hence the name: deciding to take advantage of another's trust presents an ethical quandary for the person to overcome. National health care is a classic example. If you give free health care to everyone, you can bet people will visit the doctor a lot more even if it's unnecessary. They'll be less careful, too. More people would smoke.

It's sometimes hard to tell the difference between adverse selection and moral hazard: was this person planning on betraying me or did it just occur to them after I stuck me neck out? But they are real issues that occur in your everyday life and economists have noted several ways people mitigate these problems (especially when hiring and lending). Hopefully, with just five hours before their final, my students understand their application as well.

Decrees from the Bishop

Bill Bishop on The Daily Show tonight frets over people choosing to live with like-minded people or read like-minded sources. Bishop is missing the bigger picture: this "Big Sort" is the product of a wealthier people choosing to live the life they've always wanted to. Past generations didn't like their personal beliefs challenged by their neighbors; they just couldn't afford to move away because of something so small.

It would be nicer if people were interested in challenging values they dare not challenge. But being wrong is a cost they shoulder alone. Unless, of course, they vote: a problem that decreases as the scale of government retreats. Go ahead and be irrational. Just don't make me be irrational with you.

Knowledge is Disperse

This week's Economist notes

And just 6% [of Americans] view the economy positively. Yet many Americans combine despondency about the big picture with personal contentment. More than 80% say they are satisfied with their own circumstances. Even more are satisfied with their jobs.

In other words, the concerns about the economy are overblown.

Skeptics of the positive outlook should tread carefully. One of the core rules of economics--knowledge is disperse--tells us to trust the local claim over the big picture perception. What is an individual more likely to accurately estimate: their personal circumstances or the budgets and incomes of millions of strangers?

Coase on the Coast

Russ Roberts muses about applying Coase to traffic accidents while he's in California. Pedestrians, he notes, run wild in a way they wouldn't in DC because in traffic accidents the driver of the car is usually to blame. What a wonderful coincidence that we covered Coase on Monday in my principles of microeconomics course.

Coase notes the problem is not (in the case of traffic accidents) the car when it hits the pedestrian. The problem is that both the pedestrian and the car tried to occupy the same space at the same time. Remove one of these elements and you remove the problem (like all externality issues).

In brief, the question we should focus on is who is the least cost avoider--who is in the better position to avoid a collusion? Given the car extends well beyond what most grew up maneuvering in (ie, their body) and cars move much faster than people, pedestrians are the least cost avoider. The legal action should be to make pedestrians liable for being hit by cars.

This is not, of course, meant to be a hard fast rule. If you're hit while on the sidewalk or curb or crosswalk, that would still be the drivers fault. Again, the least cost avoider holds: it's less costly for drivers to stay in the street and watch lights than for pedestrians to be forever vigilant about where every car in the vicinity is. But in cases where a pedestrian crosses the street without warning, blame should lie with them.

Remember, economics is not about good guys and bad guys. It's about a bunch of people facing costs and benefits.

Have You Hugged a Spectator Today?

A student once asked me if I thought lower gas prices would help the economy. "Not inherently," I said. "So what should they be?" I responded: "They should be at the price that accurately reflects the conditions of the market."

Economists know genuine growth doesn't come from high wages or cheap oil. It lies in efficiency because that allows us to do more with less. And the best way to get efficiency is to get everyone acting appropriately based on the conditions of the market. Thus the importance of accurate prices.

As Megan McArdle explains, this is where speculators come in. Because they believe gasoline is going to be more expensive, the price of oil today is higher than it would be and the price of oil later is lower than it would be. This allows us to better prepare for the future and adapt more smoothly than we otherwise would.

Speculators aren't "gambling." They aren't even "guessing," as McArdle suggests they are. They're estimating. They're smart people working very hard to get reality right--that's how they get paid--and they've independently agreed that prices are just going to get higher. Thank your spectator because now you'll more smoothly consume gas and you won't be caught off guard by a sudden jump in prices. Now you can plan.

HT: Mike Mills

The Island of Doctor Hayek

For the third homework assignment I asked my principle of microeconomics students the following question:

Suppose anyone could legally practice medicine regardless of their educational background. Keeping the ideas of emergent order in mind, explain the implications of such a change. Would this change be desirable or undesirable? Explain why or why not.

The vast majority (about 70%) claimed this would be, "of course," disastrous. It reminded me of F.A. Hayek's observation:

Much of the opposition to a system of freedom under general laws arises from the inability to conceive of an effective co-ordination of human activities without deliberate organization by a commanding intelligence.

To see what I mean, here's a sampling of the responses:

...there would be a significant decline due to a lack of knowledge ad resources to apply appropriate medical treatment. This would cause a decrease in recovery, trust in the medical professionals, an increase in malpractice suits, and inappropriate treatment...

The quality of healthcare would plummet. The doctors [sic] offices would be jam packed with people who may not even need medical attention.

Without medical schools people would learn how to practice medicine directly from other doctors....without the proper tests and knowledge from medical school many doctors may be ill-informed and overall perform more poorly than they would of if they learned all the rules and regulations from medical school.

There's no doubt, as I mentioned to the class, that decentralized order is messy. In this case, people will surely suffer and even die by the hand of someone with less knowledge than a typical doctor. But so much of the chaos mentioned here wouldn't happen. The danger of medical malpractice and the desire to get a good doctor will make true quacks few and far between. A "jam packed" waiting room would encourage entry or prices would increase. Medical schools would still exist and, because good doctors are still in demand, people would still attend. More might attend because you don't need to finish to practice medicine.

Most of the reasons people go to a doctor are routine concerns. Do you really need a veteran doctor to give you a physical? Or tell you that you have the flu? You're either wasting his time or spending too much on him. As Arnold Kling argues, this "Crisis of Abundance" is one of the big reasons health care costs are so high. You don't need experts on every little cough and sneeze.

Yet students rarely mentioned any benefits such deregulation would bring and some mentioned the lower salary of doctors as a negative (though in reality only the bad doctors would see their wages fall, as per the compensating wage differential, a concept that was covered in the question right before this one).

It's not obvious if this institutional change is desirable or undesirable. But the relative metric is comparing the costs of the risk and additional suffering thanks to quacks with the benefits of getting the same job done for less. And since the costs are temporary and rare (bad doctors don't last long) and the benefits are permanent, I personally lean to the favorable interpretation.

Think Before you Blame

Richard Bitner appeared on The Daily Show tonight promoting his new book, Confessions of a Subprime Lender. Jon Stewart wondered why the people who have the toughest time paying a mortgage are charged the highest rates. Bitner's reply--that they are riskier--is correct but unsatisfying.

We want it to be higher for them. High payments discourage those who have little chance of paying them back. It not only reduces default risk, it generates the incentive for banks to offer these loans in the first place.

America's financial system is not perfect, but it makes a lot more sense than it appears when you take a moment to think about it.

The Joker's Lesson on Free Trade

When I saw the midnight showing of The Dark Knight I doubt my fellow moviegoers were learning something about free trade. I didn't see the lesson at first but once I noticed it, it became painfully obvious.

***Spoiler Alert***

At the climax of the movie the Joker scares the population of Gotham to evacuate, leading to two ferries packed with people trying to escape the city. The Joker places a bomb on each ferry and then gives the two captains the detonation device for the other bomb. Ferry A can blow up Ferry B and vice versa. They have fifteen minutes to decide what to do or the Joker will blow them both up.

This is obviously a prisoner's dilemma game with the standard Nash equilibrium (the captains pull the triggers at the same time, killing each other). But that's not what happened. Each crew was overwhelming in favor of blowing the other up (confirmed by a vote), but no one was willing to actually do the deed. In other words, there's a very real morality cost that altered the payoffs. People would rather die than kill someone but they would rather have someone else kill than die.

If you look at polls Americans are mostly against free trade. (Last week's Economist cited only 33% of Americans think free trade is good for the economy.) Yet that's not how they act at the market. A choice between a cheap import and a more expensive domestic leads to people favoring the import. We don't of course need government action to limit free trade--people could just refuse to buy imports. But, as in the ferries, no one is willing to shoulder the cost of doing it themselves. They want someone else to do the deed.

Bryan Caplan notes there's a big difference between voting and buying. In buying you internalize all the costs and benefits of your actions. In voting such considerations are externalized onto someone else. Your gut feelings of xenophobia, survival, or old ideas are a lot easier to hold on to. But when faced with the true costs of your action, revealed preferences are quite different than the cheap talk from a voting booth.

Inferiority Complex

Upon grading principles of microeconomics homework I come across too many students (ie more zero) incorrectly identify an inferior good as a low quality good. This is emphatically not always true (though a correlation probably exists). An inferior good sees fewer buyers as incomes rise. Here's a few examples of inferior goods that are not low quality:

-Bikes. There's a lot of high quality bikes out there, but, as China reminds us, increasing incomes sees fewer bikes bought.

-Personal education. Most of the time people go to school to get a degree so they can earn more money. Of course if you're already making a lot you're less likely to hit the books. Bill Gates never did finish his undergraduate degree but I doubt I'll see him in class. (Note this is personal education. The opposite it true for the education of, say, your kids.)

-Studio apartments. There's nothing inherently low quality about a studio apartment. Indeed the amenties and location could be tremdously nice (in the middle of downtown, hardwood floors, new appliances).

Quality is a relative concept, of course. This makes refering to "low quality" items in an absolute context sloppy thinking. A 42-inch television is low quality compared to a 50-inch but no one's saying the 42-inch is an inferior good. An inferior good is not "good" or "bad."

In of World of Constant Opportunity Costs....

After grading the first homework of the semester semester, I thought I should take some time to clarify a bit about our old friend, opportunity costs. Most, I'm pleased to say, understood the concept (at least so far as the question is concerned). But most is not all.

Here's the question:

People often claim that hurricanes are good for the economy they affect because it creates a great deal of economic activity. While citing (and defining) opportunity costs, offer a challenge to this argument.

Opportunity cost occurs in two ways in these disaster scenarios: was the disaster economically beneficial and is it worth cleaning up?

The first question should always be answered with a no. If the disaster did not happen, infrastructure would still be intact and people would still have their lives and health. Thus resources spent to replace items or mitigate pain would instead be used to enrich an existing society. It's strictly better. Instead of losing a house and paying to rebuild it, you can keep the house and pay to expand on it (or buy a boat, or send a kid to college, or whatever).

The second question's answer is less certain. Perhaps it's not worth rebuilding. If a tornado destroys an obscure ancestral home and restoring it would benefit us by $1 million, but we could build a new school that would bring a benefit of $10 million, restoration is clearly not worth it even if we would be better off had not the building been destroyed. Just because it was worth having does not mean it is worth replacing.

People understand this distinction all the time. If a board game is destroyed in a flood, the family will certainly count it as a loss (having a game is better than not having one, all other things equal). But we wouldn't be surprised if they don't leap to replace it with the same game. They might buy a different game or buy something else entirely.

This distinction--the opportunity cost of a disaster and the opportunity cost of fixing--resolves the seeming paradox of why economists sometimes regret destruction while simultaneously refusing to repair damage. If we can stop disasters cheaply, that's great. But they are almost as unavoidable as opportunity costs and letting ruins stand is not always bad.

The Ethics of Greed

The Economist reports this week that CompartamosBanco, a Mexican bank, is making a killing in micro finance. Trail blazed by Nobel Peace Prize winners Muhammad Yunus and his Grameen Bank, micro credit loans very small amounts (a few hundred dollars) to entrepreneurs in developing countries. Usually done by nonprofits, CompartamosBanco is a notable exception.

Lending to those in developing countries is expensive because the social, legal, and physical infrastructure is so lacking. The Mexican bank spends about a $152 a year per client. No wonder its interest rates run 79%--usury to most developed countries. But the customers gladly accept the rate. CompartamosBanco has nearly one million borrowers--a far cry from Grameen Bank's seven million but impressive nonetheless.

CompartamosBanco's success encourages new entrants risking their own money (seven new competitors in Mexico alone) while Grameen continues to rely on subsidies and donations. As the economy of scales takes into effect, interest rates fall (seven years ago it used to be 115%) and yet more people rise out of poverty. Not only is this yet another example of how profit seeking helps us all, it reminds us of one of the strange lessons of economics: the only way to get low prices is to allow people to charge high ones.

In Praise of Spectators

Diane Rehm agreed with a caller today that speculators are to blame for rising oil prices. Her guests (J. Robinson West, Athan Manuel, Stephen Power, Chris Oynes) offered no serious dissent and often repeated the concerns that these investors are acting irrationally, irresponsibly, and at the expense of the people.

Yet we should celebrate their acts. By pushing oil up now rather than later, we sooner get an accurate price meaning we sooner get adaptation to that price. As everyone on today's show recognized it takes a long time to move oil from the ground to the pump. Without spectators oil would move up slowly and sometimes dip down, making investments in production far less likely.

It is the job of an investor to gather all the information from all over the world (including places you wouldn't expect) and come up with an unbiased prediction. It's how they earn their livelihoods. That doesn't mean they never panic or are subject to emotions. We're all human after all. But their irrationality is much more rare than the uninformed panic of the voting public.

Pillsbury ND: Where the Marginal Vote Matters

Pillsbury North Dakota is a small town. So small that in a recent election for mayor no one voted, not even the candidates. Here is a case where voting definitely would have changed the election, although it might not have changed the outcome of the town rule:

The council meets about five times a year, Brudevold said. Members are each paid $48 annually, and a good portion of that goes for doughnuts at the meetings or gas to get there, he said.

Pachelbel For the Modern Rocker

Art Carden wonders if this is art. I bet it is, but I ultimately don't care. It rocks.

Welcome To the Jungle

Paul Krugman argues America's food quality is what it was a century in the time of Upton Sinclair's The Jungle. A lax FDA (and its industry cohorts) is to blame for the recent "tainted spinach, poisonous peanut butter and, currently, the attack of the killer tomatoes."

Economics is a strange discipline because it really just requires people to take lessons they follow in their everyday life and apply them consistently. The lesson here is that we don't want zero risk when it comes to food. Do you boil every glass of water that comes your way? Demand tests on meat that you get in a restaurant? Grow your own food? Avoid eating at authentic restaurants abroad? Failure to do these things puts us at risk but we gladly accept it. Avoiding that risk is too costly: zero risk is not optimal.

Ensuring consistency does a lot for a good argument. Krugman scoffs at the free-market argument against the FDA--that "private companies would avoid taking risks with public health to safeguard their reputations and to avoid damaging class-action lawsuits." And yet he warns that a lack of regulation for ensuring solid food safety is not "just bad for consumers, it’s bad for business." So firms won't ensure safety on their own because they are too greedy but if the food quality is poor then it's bad for business? I bet he doesn't take a UV light to restaurants, either.

People Are Not Passive

Are there limits to growth? That's what people tell me while citing higher food prices, a planet of 6.7 billion, and cities often exceeding ten million. "There are too many people," they say. What nonsense.

Eleven years ago, Nobel Prize winner Norman Borlaug wrote that with current technology we could feed 10 billion people (a population we're not going to reach until around 2050). With 21st century technology we can surely feed more. Alex Tabarrok reminds us that US land use for crops has been steady from the late 1930s to the late 1980s, a trend likely continuing right now.

Whenever people make note of the resource usage of developed countries or the "carrying capacity" of the planet, they always ignore that people are not passive. We are not infants, sucking thoughtlessly away at the tit of the world. We create more than we consume. Our inventions exceed our immolations (at least in today's world). For every mouth to feed there is a mind to think, hands to work, and feet to move. We cherish our lives, our wealth, and our hope for a better future and we will lash out with every appendage to maintain our true and steady course.

Are there limits to growth? Probably, but we're not going to encounter then in our lifetime. Or even in our grandchildren's grandchildren's lifetime. History is replete with doomsayers and prophecies of cataclysm. And as seductive as their wild-eyed claims are, as invincible as they seem, they're always wrong. Never forget that.

When To Recycle and When To Not

There are four plastic bags near the front door of my parents' house each stuffed with a few weeks worth of newspaper bags. This is my mom's latest attempt to save the world. In her infinite foresight she's gathering these bags to "keep them out of the landfill." She plans to send them back to the newspaper company so they can reuse them. I somehow doubt they will.

Plastic bags are tremendously cheap, evidence in that are giving them away to customers. They still cost the company something but I doubt it'll be worth sorting through the bags to reuse them. Recycling's expensive and often not worth the time and effort. Though in some cases, like recycling cans, it is. People are willing to pay for the savings it brings. Note soda cans are one of the few places you are paid to recycle.

Recycling reduces space used in a landfill but so what? Is landfill space really so scarce that this is worth it? If it is, why aren't we charged per bag or per pound thrown out? Part of this is due to the city-run industry but the a bigger factor is that landfills aren't hurting for space, particularly out here in Iowa.

If you're not being charged to throw it out and if no one's willing to compensate you for your time it's not worth recycling. See a past post on this subject here.

Asbestosis Gone Wild

A court in New Jersey recently ruled Spanish citizens can now sue Owens-Illinois and other asbestosis-related firms based on exposure from U.S. ships. This does not have to translate into actual harm from the exposure. Like most asbestosis litigation, post hoc ergo propter hoc works just fine in the court of law. Indeed, the even possibility of harm is enough to cost Owens-Illinois. To punish firms so overwhelming cheapens our society in two ways.

First we get too little asbestosis. Asbestosis is not evil and its optimal amount is not zero. It's useful and safe in many areas of our society. (Indeed, its wide application is why asbestosis litigation never seems to go away.)

Second we lose good ideas in the process. This is not limited to opportunity costs coming from litigation-related expenses. The possibility of similar attacks can destroy a development before it even starts. If asbestosis litigation can completely ruin an industry, companies are less willing to engage in ideas that they think could be twisted down that same route. Sometimes this is good but the level of asbestosis litigation likely makes firms so risk averse that the net effect is undesirable.

This second issue is critical but often ignored because this lost opportunity is never seen (be definition). It makes it difficult to estimate the true cost of asbestos litigation. But if the technological and economic progress in the past few decades is any indication, that cost is a lot higher than most people might think.

Order At A Bargain

This week on EconTalk Allan Meltzer poetically reminded us that

A country that won't experience a small recession will end up having a big one.

Free markets are messy things and it won't be perfect all the time. Nothing will be perfect all the time. We must remember that slowdowns and corrective recessions are the price we pay for the benifits of a dynamic and enriching society. And we're getting a damn good deal.

If You Build It, They Will Ride

Paul Krugman claims Americans face a paradox as we adapt to higher oil prices and away from our suburbia lifestyle.

Public transit, in particular, faces a chicken-and-egg problem: it’s hard to justify transit systems unless there’s sufficient population density, yet it’s hard to persuade people to live in denser neighborhoods unless they come with the advantage of transit access.

This is not really a big problem if you remember your marginalism. Extend a single rail line through a residential area. If oil prices are as high as everyone says they are, people will move to that area. Apartment buildings will replace townhouses (and if you're smart, you bought some of that land around the rail before the construction was announced).

Firms solve this problem all the time. Wal-Mart constructs its stores in the middle of no where. It doesn't fret about the low population density (it prefers it, actually) because it knows people will come to it. Same goes with any large scale project that people will want. Assuming, of course, they want what you're building.

All Bad Stuff Isn't Worth Avoiding

As the semester closes, a student came in to collect his final and we got to talking about immigration. He's concerned about illegal immigration, largely for security reasons. Keep out the illegal immigrants and you'll to keep out the terrorists. It only takes one to make a disaster, after all.

But the optimal amount of terrorism (or pollution, accidents, illiteracy) is not zero. It might seem so because we really don't like seeing bad things happen (terrorist attacks being some of the most tragic) but complete prevention is a very costly thing to do.

Reducing terrorism requires the command of a vast amount of resources. Thus increasing security reduces the amount of things we can do (workers are busy patrolling borders). This "opportunity cost" is can actually cost lives: doctors tend soldiers with heat stroke instead of citizens with heart attacks. Terrorism reduction through border control also reduces the number of people who peacefully work in the US (the vast majority of them) so our opportunity cost deepens. We not only have fewer people producing other things, we have fewer people producing at all.

The cost of terrorism reduction increases faster than it falls. Picking out the obvious amateur is pretty easy, but once all the easy guys are caught, tracking down the elusive expert is much harder. For each percentage point closer to zero we get, that single point costs more and more. Our "increasing marginal cost" puts a tremendous amount of strain on our economy without obvious benefit beyond that one more person captured.

Preventing terrorism in the U.S. is particularly expensive. The country's size makes it that much harder to find terrorists. Its decentralization means any terrorist attack will have a small impact on the functionality of the country. Its productivity means that we are giving up so much more when we wander the desert looking for illegals. The accounting costs are very high. The opportunity costs are very high. The benefits are pretty low. Zero is not the optimum.

Playing with Statistics

Bill Moyers appeared on The Daily Show tonight and fretted over the rising gap between "the rich" and "the poor." That these terms are arbitrary and vague didn't seem to bother him. Nor did he seem to mind that the numbers are useless. Comparing a gap now and a gap twenty, ten, or even five years ago assumes nothing else has changed.

But lots of things have changed, including the people the numbers are looking at. People are moving higher up in incomes and starting at lower incomes (because of immigration, more schooling, etc). This is a great scenario but Moyers' naive examination of it would suggest disaster. When we follow the individuals (which we don't do enough of so the data is a little old), "....the bottom 20% in 1975 were also in the top 40% at some time in the 16 years follow." (Sowell, p135) Here's a table from Steve Horwitz's page that gives us a more complete picture:

Income Mobility 1975 to 1991 (UM Data)
	Bottom 20% (1991)	Fourth 20%	Middle 20%	Second 20%	Top 20%
Bottom 20% (1975)	5.1	14.6	21.0	30.3	29.0
Fourth 20%	4.2	23.5	20.3	25.2	26.8
Middle 20%	3.3	19.3	28.3	30.1	19.0
Second 20%	1.9	9.3	18.8	32.6	37.4
Top 20%	0.9	2.8	10.2	23.6	62.5

Why Are There No CEO Assassins?

My newly found of love of Burn Notice reminds me of a question Robin Hanson posed to use a few weeks ago. Why don't firms assassinate the CEOs of their competitors? It seems pretty strange but industrial sabotages is an old practice and a highly paid CEO is the lynchpin of the company.

It's not like it would be that difficult to get away with it given the resources these firms have at their disposal. Besides, most murders don't get solved if they are done halfway smart and pulled off by someone not in the system. Mob families have contract killings all the time (using "all the time" in a loose sense). So why aren't CEOs dropping like third world dictators? Here's a few theories.

Rule of law. This is a bit of hand-waving but it's worth noting that my above examples of common assassinations (mobs and developing nations) take place in contexts where the rule of law is precarious at best.

Externalized benefits. Your gain is your third party's gain. But she's also your rival and didn't have to pay for the hit. Even if just two firms are the biggest boys on the block by far, the threat of a new competition (which would surely arise) could get you to shrug your shoulders. Why off the CEO of Pepsi when that will allow another Pepsi to rise up? Meanwhile, Pepsi's still there and now you have two rivals.

Retaliation. This is how mob bosses (and some nations) keep the peace. A CEO is less willing to off his counterpart if he believes they'll respond in kind.

Built in redundancy. In a weird way, every firm large enough to make the risk worth it is prepared for it. It's likely not explicit, but every shareholder knows their CEO could have a heart attack or die in a car accident. If the CEO is worth his salary (and the economic analysis suggests he is), then he's worth taking out an insurance policy for. This means there are other guys who know just as much about the firm and are probably almost as good as the guy in charge. True lynch pins (such as Steve Jobs and Warren Buffet) are rare. Ok sure, you could just take out the back ups, but how do you know who they are? And more than one mysterious death will raise attention--the chance of getting caught rises pretty quickly with each additional dead body.

Shhhhhhh. Of course for all we know CEOs are killed, but we just know them as heart attacks and horrible accidents. Remember the whole idea is not getting caught.

Upcoming Final Exam

I hope my money and banking students can answer the following:

Select one of the methods we discussed on how expansionary monetary policy increases GDP (there were five in total, from lecture 19) in the short run. Detail the logic (i.e. the series of causation) of why this avenue of monetary expansion increases GDP. Why won’t this work in the long run? At what point in the causation does the method you selected stop working? Why?

Why Banks Hate Foreclosures

In the mess of the sub-prime collapse, you occasionally hear that the banks purposely lent to people they knew couldn't pay back the loan. This why they get the loan money and keep the house. Seems like a pretty good deal. Why don't banks do this all the time?

Banks are a business--they don't really want the house, they want the money. You can't pay your workers with bits of a home. You can't use it to invest. You can really only use it to live in, but all the management staff has a place to live already. Homes are what economists call "illiquid" assets--assets that can't turn into other things easily. Banks prefer liquid assets such as bonds, futures contracts, stocks, and cold hard cash.

Can't the bank just sell the house it forecloses? That is what they try to do, but each day it takes costs the bank money in the form of lost opportunities. CNN reported that people who gave up the home to the bank tend to trash the home. They rip out piping, steal toilets, take out cabinetry, lay claim to fixtures, and punch holes in the wall. One family grabbed a pair of decorative columns from a home. Homes like these have to sold at a discount or the bank pays to fix them up. And then they have to pay to keep the house from accumulating additional damage while it sells. It all adds up to time and money down the hole in the floor where the toilet used to be. And banks don't like it.

There Is No Peak of Progress

James Howard Kunstler appeared on the Colbert Report today promoting his new novel about a world without oil. Kunstler claimed we have hit the peak of oil and now we must get off of oil and abandon our Wal-Mart suburbia ways.

Kunstler is mistaking economics with physics. There's a finite amount of oil, but that's not what we care about. We care about energy. As the price of oil rises we find new sources of electricity. We improve wind, solar, nuclear, coal, geothermal, and oil efficiency. We find new deposits, including things we never considered oil before. Someday we will not use oil, but it will be phased out, not ripped away. Kunstler imagines the oil wells "drying up" will come as a surprise--a paradox concerning that's what everyone talks about. Assuming ignorance on the part of the oil companies (who's fortunes are made on the stuff) is patently absurd.

Colbert wisely (though I doubt he meant it this way) brought up the terror of Y2K, asking "When's that going to hit?" I remember the scares of the millennium bug vividly, the concern that planes will fall out of the sky and the world will suddenly end. It didn't. No one wanted to go back to the Stone Age so programmers fixed the problem. Now we are better off than we were eight years ago, and the Y2K scare a distance and quaint memory. Kunstler's novel will surely follow the same path.

Worlds Within Worlds

Bill Maher fretted to Jeffery Sachs Friday that if all people of the world consumed like Americans we would need five Earths to supply the resources. Yet a hundred years ago, we could tell a similar story using Europe as a baseline instead of the States. How can I make this claim?

What Maher and Sachs are ignoring (as too many people do) is that if the people of the world used more resources, they would be able to produce more of them. More creativity, more inventions, more ideas, more productivity, more investment, more hands at work, more active minds. The history of the world is replete with scares of shortages and the panics never hold out to the adaptive world of free markets.

Increasing Returns and Life

A few days ago Arnold Kling applied the law of diminishing returns to everyday life. In other words, he explained how doing the same things get boring and where in our life can we avoid this trap.

According to Kling, people do it an awful lot. They read books by the same author. They stay forever in the same organization. They're hesitant to change jobs. On a personal note, the only fiction my mom seems to read are murder mysteries and I sometimes wonder if she ever gets bored with them or can guess the guilty sooner.

Yet we also have to recognize there are increasing returns. If what you experienced in initial consumption can be carried forth (in part) to future consumption, then the time time you engage in that activity, your change in satisfaction can higher than what it was before. For example, the first time you tell a joke won't be as good as the second time. The learning experience you gained from the first time enhances your telling for the next time. You might be a little bored of the joke because it's in your recent memory, but the smoothness of the execution of the punchline more than makes up for it. But it doesn't have to be educational in nature. A little bit of the drama carries from experience to experience. Similar experiences can enhance each other (which is why there are so many people who throw themselves into a TV show).

The same could be said in other areas people specialize in, such as their job, a discipline, or a sport. You can think of it as going to the same amusement park each day in a week. Each time you experience another part of it, but can also avoid the costs of constantly learning how to navigate its paths. Obviously, this can't last forever (not even academics think in terms of the discipline every waking hour) but it does suggest that dabblers may well be served to throw themselves into a discipline instead of constantly moving about. And perhaps it's worth it to visit the Louvre twice in the same visit to Paris--you're surely discover great things most people don't notice.

Earth Day Is Capitalism Day

On this Earth Day, George Mason University's Don Boudreaux celebrates what he calls Capitalism Day:

...far more than any other, has made human lives clean, safe, dignified, and culturally rich. Capitalism is also responsible for giving people the wealth and leisure to permit them to mis-perceive nature as loving and bountiful, and to enjoy nature in a way that few of our pre-industrial ancestors could ever have enjoyed it.

It is this latter point that is often ignored. A wealthier society is a gateway to all other things we value. Wealthier societies not only have more stuff (from Wiis to advanced medicine) and more options (for jobs, living areas, places to travel) they also give us the gift of time.

Time is our most precious resource. Our ability to save time (though greater productivity) is critical to our happiness. We spend time to enjoy the company of others, find love, seek enlightenment, discover our purpose in the world, and enjoy nature. In a lot ways, nature is a really nasty thing. It's a little strange we leave the safety of modern society to visit it. Nature is filled with bugs, dirt, and disease. The sun spews radiation. Some hiking trails are small and uneven, making it easy to get lost and then sprain an ankle. There is no plumbing, no Internet, and no one to gut and cook a fish for you. Poison ivy crops up in unexpected places. Water needs purification tablets and food needs to be hoisted in the air out of the reach of wild animals. Birds scream all the time. And this assumes it doesn't rain.

Few would ever want to live permanently in such a place and most that try don't last long. But all this "roughing it" can be fun if it's temporary; nature is best left as a tourist attraction. But only with the time capitalism awards us can we afford to "get away from it all" for days at a time. Visitors cut themselves off from the world that they rely on for everything they brought out to the wilderness to make sure they don't die. If there was no capitalism, if people were too busy to see how beautiful nature can be, we likely wouldn't have an Earth Day which celebrates the wilderness. Or, worse yet, we'd be out there all the time.

The Nature of Trade

Jeff Faux (Economic Policy Institute, founder) on the Diane Rehm Show argued against NAFTA today, arguing that globalization changed the nature of trade. It's no longer about exchanging goods but about US firms manufacturing abroad and importing back to the States. The trade deficit, he concludes, is a problem.

Mr. Faux should know better. The trade deficit (aka the current account) is an arbitrary distinction between the net flow of goods and the net flow of investment (capital account). By definition, the two add up to zero (the balance of payments or BoP). Americans import goods and in exchange they spread the US dollars that give foreigners the ability to invest in the US economy. As a result, US citizens maintain a very low savings rate without losing the technological and economic progress that investment generates.

Here's a simple graph to drive home the point:

Keep Your Numbers Real

Today CNN commented on the Pope's visit to New York City, arguing it would bring $50 million to businesses in the Big Apple. They compared this to when Pope John Paul II visited the city in 1995 who spent $45 million. They then briefly commented why the Pope might be bringing in more and what's changed in the past twelve years.

But they didn't mention what's definitely changed: the price level. Usually when they bother to adjust for inflation, they mention it. But not today. A simple check reveals that the real value of the last Pope's visit was $62.2 million--over $12 million more. Say what you want about popularity or Pope expenses, but always check for inflation.

The Secret Safety Record of Nuclear Power

When it comes to the environment and electricity there are two basic schools of thought for clean energy: nuclear power versus wind/solar (and occasionally hydroelectric). Nuclear power has the advantage of being reliable (the weather doesn't effect it so it's great for base-line power) and cost effective. Its main problem is that it's scary.

There's only been two major accidents in nuclear power history--Chernobyl and Three Mile Island. Lots of other accidents involving isolated radiation leakage occur, but it's the disaster scenarios that people are scared of. It's very strange, much like how people are afraid of flying because there's been a few big accidents yet don't bat an eye at the thousands of car wrecks a year. If we want to truly judge the safety of nuclear power versus other sources, let's examine how many people die per terawatt-hour. Note these deaths can occur in many ways, such as accidents, pollution, construction and maintenance.

Coal: 32.6
Solar: 0.83
Wind: 0.4
Nuclear: 0.052

The solar rate are based largely on rooftop solar and most of it comes from the danger of installing it (roofing is one of the most dangerous occupations in the States). See this article for more information. I picked up the coal and nuclear numbers from this article.

Granted, it's difficult to tell how dangerous nuclear power is given the long-term effects of radiation and issues regarding nuclear waste. At the same time since nuclear power is so much cheaper its customers could afford other things that they couldn't otherwise such as healthier food or better medical care. The net effect is far from obvious but it seems unlikely to overcome the ten-fold increase in the death rate compared to its clean alternatives. Nuclear power is a lot safer than you think.

Contracts and Adultery

Contracts are great. They let us plan our life with confidence. They secure trust and obligation. Even when informal, they just make everything run smoother. Contracts, in all their forms, are at the heart of a well functioning society.

Marriage is a contract: "I give me life to you so long as you give your life to me" etc etc. Cheat on your spouse and you get what's coming to you. You made a promise; make sure you keep it. It all makes sense. But some have a very strange approach of cheating: they blame the cheating partner just as much as the one they cheated with. They call them home-wreckers, sluts, jerks, and monsters. Sometimes they are threatened with violence. Some are killed. Even if they're not married, they're called adulterers.

This is nonsense. Your spouse is clearly in the wrong, but the other party isn't (unless s/he's married, too), even if they knew about the marriage. They didn't break contract. They may have allowed your spouse to break it, but so did the hotel they stayed in. Third parties made no promises to break.

Suppose Ethan promises Steve to sell him a book for $10. Then James, knowledgeable of the contract, offers Ethan $20 for the book and Ethan takes the deal. It's hard to imagine Steve being angry at anyone other than Ethan, but yet the same logic doesn't apply to marriages. You might say these third parties aren't respecting marriages and that's their flaw, but you could say the same thing about James and contracts. And since marriages are contracts, that doesn't get us far. What's special about marriage?

I have yet to hear a good answer, though married people seem to loathe this position more than single ones. The best explanation I can come up with is that they just don't like the idea of someone they care about cheating on them and they'd rather blame someone other than the one they love. So the lesson today is that if your spouse (or girlfriend, or boyfriend) cheats on you, the problem lies with them and your relationship, not some random person you just want to be angry at.

Listen to Your Mother

I have vivid memories of my mother insisting I wash my hands before dinner. I remember thinking: "What on earth does she think I've been doing that would justify all this hand-washing? I'm eating pasta, not performing surgery." But insist she did and the rule has (somewhat) stuck. I live a pretty quiet life--academia isn't exactly a dirty job.

Doctors are a different story. They expose themselves to dirt and disease with every patient they visit. But for some reason, they rarely wash their hands. Even though washing between each patient is time consuming, using ultraviolet germicidal irradiation (and wearing rubber gloves to mitigate the dangers associated with constant exposure) would cut that time down to a negligible value.

We talked about this issue and others (interns work for 24+ hours, doctors wear "sterile" scrubs to the cafeteria, aspirin before a heart attack is rarely used) during law and economics today. The existence of these deficiencies is a puzzle. They are very easy and effective ways to save lives yet in the avalanche of medical malpractice suits they are rarely employed. More puzzling, they are rarely cited as a cause of negligence--a lack of this or that test is more common.

The latter seems to explain the former (hospital's aren't willing to accommodate because no one's complaining) but that only makes the latter more puzzling. Most people who file a suit don't have a legitimate claim of harm, but surely they could secure a victory if they point out the doctor/hospital didn't take simple steps for avoiding harming. Why are doctors being sued for not ordering an obscure and expensive test and not being sued for being less hygienic than the seventeen-year-old at McDonald's?

My best guess is that people don't want to believe doctors could be so careless. This doesn't quite explain it since you'd think the possibility of infection or death would encourage people to think more carefully (rational irrationality doesn't get us far). Still it is consistent with the fact that of the people who have a legitimate case against their doctor, only about 2% sue. What a strange world we live in.

The Canadian Giant

When Americans think of Canada, a handful of quaint images usually run through our heads. Lumberjacks. Mounties. Maple syrup. It might seem backwards, rugged, or even primitive. But Canada is America's largest trading partner, greater than even China or India. There are virtually no tariffs put on items exchanged between the two countries--about as close as I've ever seen of actual free trade. It's a wonder Lou Dobbs doesn't focus his wrath on America's northern neighbor.

On the most recent Southpark episode, Canada becomes so angered by their lack of respect worldwide that they strike. After an unknown course of time (several die during the strike due to hunger and fatigue), it's revealed that Canada lost $10.4 million in lost production as a result of the strike.

I suppose the writers felt this was a high sum or knew it wasn't and used to to poke fun at Canada. But in all honesty, for a country of 33 million people, that adds up to less than fifty cents a person. The Canadian economy is actually quite robust (no doubt in part due to trade with the US and other countries), with a GDP per capita on par with the United States ($38,200 versus America's $43,594).

To capture how small the number is, understand that we can use it to estimate the length of the strike. Canada's GDP is $1.274 trillion. That means the strike lasted for 0.00000816 years, or, ignoring weekends and assuming an eight hour work day, 1.02 minutes. (I use USD here; note that if you switch to Canadian dollars it changes nothing since you'd be multiplying the numerator and the denominator by the same constant.)

The world economy is huge. Mind blowingly, fantastically huge. It is so large, Americans scarcely notice a nearby one trillion dollar economy and the toil and effort of a population the size of California. How great we have become, and how small each of us are.

The Paradox of Control

Eliezer Yudkowsky at Overcoming Bias explained scarcity as psychologists think of it: as something becomes less attainable, you value it more. It's not clear how widely this applies but I can see it function in many areas such as dating, fads, and fashion. While Yudkowsky explains the phenomenon with evolutionary psychology (our ancestors had to grab what was scarce or they'd die out) we can also see it as signaling. If you have something that's hard to get, it suggests you're important, hip, or otherwise exceptional in some way.

Contrast this with Robin Hanson's theory of regulation. If a regulator can require something of a person but doesn't, the person will likely conclude doing what the regulator wants isn't all the important. If you can ban something but don't, then it's not all that dangerous. If you can require something but don't, then it's not all that helpful. A lack of regulation is a signal that tells people that if they made a bad decision, they'd still be alright.

Again, it's not clear how widely this framework applies but we can imagine quite a bit of overlap. Drugs come to mind first. If you ban drugs, people will want to do them more to either suggest they're hip or to get them while they can. If you don't ban drugs, people (possibly the same group, possibly different) will then conclude they're aren't a big deal and use them. In other words, if you don't want anyone in a society to use drugs, there's nothing you can do about it.

What About the Rest of Us?

There's a Breast Cancer Protection Act currently circulating in Congress to require health insurance companies to cover a minimum 48-hour hospital stay for mastectomy patients. Makes sense that women wouldn't want to be forced out of bed right after surgery, but what's that going to do to the rest of our premiums?

Is Wal-Mart A Collective Action Problem?

Wal-Mart gets a lot of criticism from a long list of groups from environmental to protectionist to labor union. People complain it destroys jobs and runs local stores out of business. None of these arguments hold water (environmentalism is about private property, free trade emboldens economies, Wal-Mart only works because people choose to go there, etc) and I have yet to hear the rara avis: an anti-Wal-Mart argument that makes economic sense. On a theoretical level, I think I have one.

Consider a small town. Each of these people value two things: their downtown mom-and-pop stores (that small town feel) and low prices (everyone likes a bargain). Let us also suppose that each person values the small town atmosphere over the prices--in other words they are willing to pay a premium to keep the charm of the hamlet.

Now suppose a Wal-Mart comes to town. Each resident has a choice between shopping downtown (and thus supporting it) or shopping at Wal-Mart (and thus get the lower prices). Since the downtown won't go away if one person "defects" to Wal-Mart, that defector can enjoy low prices and still have that small town feel they love so much. It's strictly better. (Note enjoying that small town feel does not require actually trading with them--they simply walk along Main Street and breathe in the atmosphere.)

Naturally everyone has an incentive to do this, thus everyone goes to Wal-Mart (or a lot do) and the downtown disappears. (Set aside any arguments of downtown revival because people can now afford more stuff.) As an individual, you can choose to end your defection and go downtown, but you, lone patron, will not save the stores. It will only work if everyone (or a lot) of people will work with you. But their personal incentives doesn't lend them to that so no one does. It's a collective action problem.

The downtown atmosphere is what economists call a positive externality--people who aren't paying for it still are able to enjoy it. The town could solve this issue by walling off the downtown and charge a small fee to those who wish to visit it. Taxes to the stores could be reduced by a proportional amount (who could then decrease their prices slightly) and the only difference ends up being that free riders can no longer ride for free. Naturally, the town could also ban Wal-Mart if it turns out internalizing these externalities prove too costly (which it very well might be).

Anti-Wal-Mart groups who wish to use this argument should exercise caution. The assumptions are rather strong (nobody is willing to swap low prices for their downtown) and demonstrating they apply to a given community is difficult. Moreover, the establishment of this argument can quickly be applied to areas the group may not desire. If one can ban Wal-Mart on the grounds that low prices are too expensive, then one can ban Internet access, delivery services, resident mobility, and a host of other options on the grounds that people cannot be tempted by alternatives lest the downtown is abandoned. The line between preventing a collective action problem and outright tyranny is a thin one indeed.

Gaps In the Logic

A lot of dirt is being thrown at financial institutions lately and lot of it's nonsense. Near the top of that nonsense list are the accusations of racism. True, blacks have a harder time getting a loan; no one is denying that. But gaps in outcome does not imply discrimination. As Thomas Sowell points out in his new book,

[In two studies in the early nineties] whites were denied conventional home mortgages loans more often than Asian Americans. The same reasoning that led to the conclusion that blacks were being discriminated against in favor of whites would lead to the very questionable conclusion that whites were being discriminated against in favor of Asian Americans. But however questionable that conclusion, we cannot simply accept empirical evidence when it supports our preconceptions and reject that same evidence when it goes against those preconceptions...A later study showed that Asian Americans took out expensive subprime loans less frequently than whites did--but again the media focus was on black-white differences in the use of costly subprime loans and again the conclusion was that racial discrimination in access to conventional loans explained the difference.

Reality is always a bit more complicated than we'd like it to be or even expect. In the social sciences controlled experiments dwell past the edge of ethics so we have to rely on the observed data with all its chaos and imperfections. With that in mind, we must then look at as much of it as possible so we can parcel out the truth from the nonsense derived from our preconceptions.

Rick and Uncertainty

I hope my money and banking students can answer the following:

T/F and explain.

If a payoff is uncertain (not merely risky), then you cannot calculate its expected value.

Evolutionary Progress

Among the first lesson I teach my money and banking class is Joseph Schumpeter's insight on economic change: creative destruction. It's a strange term but economics is strange itself and sometimes requires language that on the surface doesn't make sense.

Schumpeter understood that economies grow by creating new ideas while simultaneously destroying others. It is not a stationary process but one of constant change. Creating many ideas means society has many options and thus many good innovations. But destruction is equally important. It allows the market process to move resources from bad or obsolete ideas and move them to desirable ones. We not only get the good stuff, we get a lot of it. But that means destroying the bad--or just not as good--options.

People generally recognize the importance of creation. The role of destruction is much harder to grasp. And so it was today when Lou Dobbs once again expressed concern for a loss of manufacturing jobs. He was confused how officials from the U.S. military could defend free trade and building equipment abroad while these jobs are destroyed. But employees are fired, not murdered, and they will go on to do other things. It is from this destruction that breathes new life into the economy and allows the world reinvents itself once more, as it has done before anyone alive today walked the earth.

"No Lye" but a Lot of "Tomfoolery"

I recently picked up a copy of Tulani Kinard's No Lye, a book promoting "natural hair care" for African American women. Surprise, surprise! State regulation was advocated in the same breath as upholding tradition!

Kinard's argument is straightforward: Age-old African hair care methods are safer, healthier, and self-esteem building. In keeping with these traditions, black women today should braid, loc, and twist their hair.

"Now for the clencher": Increased demand for these traditional hairstyles require legal definitions for the techniques and certified professionals to do them.

Gee, these techniques supposedly survive today because of hundreds of years preservation by women who weren't certified. Why change all of the sudden now?

Yea, Governator!

I was appalled when I heard about this recent ruling against California's homeschooling families. Considering that many homeschooling parents - like my own - are better educated than our credentialed public school teachers, requiring the former to submit themselves to special training is ridiculous! I'm really happy that the Governor has made a statement against this ruling and the Home School Legal Defense Association (HSLDA) petition has racked up thousands of signers. I'd encourage Californians to contact their state legislators and House representatives about the issue.

First Kentucky and Now Egypt

When I saw this, I nearly fell over laughing. Copyright the pyramids? Ridiculous! The fact that every little kid is amazed by pictures of pyramids in history books is probably the only reason why they later visit Egypt and spend gobs of American money there as tourists. Please tell me that their copyright laws won't hold up here in the US.

Reward Those Who Know

Rep. Patrick McHenry (R-North Carolina) asked CEOs dragged into Congress today of Paulson Credit Opportunities Fund, which made billions betting the housing market would plummet. McHenry spoke in distaste of this success.

The congressman should think before he speaks. If Paulson has a unique insight in the housing market, don't we want his firm to act on it? By rewarding people who act on accurate information, countless others have a reason to search for problems before they become disasters. Offers of $1,000 for every mistake found leads to very accurate textbooks.

Dump The Dumping Laws

Right now, an old friend of mine is awash with paperwork. He works for a company in the Midwest, importing steel from China. Last month his firm received a notice from the Department of Commerce (which insists on call itself "the Department" while abbreviating virtually everything else). They received a petition that my friend's firm (along with several others) are importing at an unfair price. An investigation is now underway.

First the department required that they spend dozens of hours filling out forms that summarize the company's activities with China (which basically means all their business). Then the department used that information and did acomparison study with India to determine their prices were "too low." The report reads why this is a problem:

The Petitioners contend that the industry's injured condition is illustrated by reduced market share, lost sales, reduced production, reduced capacity utilization rate, reduced shipments, underselling and price depressing and suppressing effects, lost revenue, reduced employment, decline in financial performance, and an increase in import penetration.

These are better known as the effects of competition.

The importer must now spend hundreds of man-hours demonstrating they operate in a free market or be hit with massive fines. People often complain that in an unregulated free market, corporations will set prices too high. Strangely, they now
argue that prices are too low because this company isn't in that same uncontrolled environment.

Earn Rewards Everytime You Stay Married

UTango is offering major amounts of money for remaining a loyal married customer. Don't see anyone crying "Discrimination!" yet, but at least one poll suggests that there are some people out there who don't think that it's worth rewarding.

Money for Nothin'?

A few friends of mine works on commission in jewelry store. The other night, one of them apparently had a bad shift, selling below what he normally does. This was no fault of his; few customers came by. What should be done to improve traffic is not clear, but anyone can tell you that paying my friend a higher base salary will change nothing. His payment is the reward for helping the business do well, not the source of it.

Why then does Paul Krugman continue to insist that low consumer spending is the chief problem with our economy? Like commission, consumer spending is a reward for growth, not its source. Like commission, its fall can be a sign of poor growth. And like anything else, you can't treat the problem by treating the symptoms. Any money sent to the American people is money either taken away from them as taxes, taken from investment as debt, or taken from everyone as inflation. To prescribe a stimulus plan is to prescribe magic, gambling our economy on ignoring the all-too-true adage, "There's No Such Thing As A Free Lunch."

Jobs Americans Won't Do: Win Oscars

All acting Oscars went to foreigners this year, and foreigners also won various other awards. I'm waiting for some nonsensical rant from an anti-immigrant zealot to declare the end of the American film industry since non-Americans are doing so well.

Democrats Vow To Block Out Sun

Exit polls from Wisconsin tonight revealed that a 70% of Democrats believe "trade with other countries causes the loss of American jobs." Both candidates argue against outsourcing and support having more jobs kept in America. Competition with cheap foreign labor and goods seems to be a great evil for Democrats.

Perhaps soon we'll see Hillary and Obama blame the sun for its product that floods our nation's borders. A product it sells for free. Free! Think of all those jobs the sun's rays take away: we have fewer electrical engineers, lighting manufacturers, power plant designers, construction workers, steel workers, glass blowers, and so many others. If we are to take their economic argument seriously then we must entertain the value of ending our dependence on foreign light.

Sen. Obama's Two Faces

In the midst of his victory in Wisconsin Obama spoke of respect for the free market and the importance of trade. But a sentence later he declared to give tax breaks to domestic industries to assuage outsourcing.

The logic of the free market does not stop at political borders. Entrepreneurs do not become stupid once they cross over to Mexico or China or Germany. Products made overseas are not inherently undesirable. And ones made within this country are not handed down from God.

Change is the essential element of all free markets and Sen. Obama should know this; he is the candidate for change. So he should celebrate our economy's evolution from manufacturing to service. He should revel in the constant experimentation and that remains so prominent. He praise people who find better ways to make the things we desire, embrace those that invent tomorrow's standards, and inspire more to engage in our oh-so dynamic economy.

Few forces are as potent sources of change--real, positive social change--than that of the free market. But it works best if we leave it unmolested and free to go places some may not want it to. As a self proclaimed free marketer and the candidate of change, Sen. Obama should know this.

The Greater the Risk, the Sadder I Am

Michael Shermer at the LA Times wrote about loss aversion: that people are willing to take a financial hit to avoid any pains of regret. This follows nicely from my money and banking on Monday, when we explored the equity premium puzzle.

Adjusted for inflation, equity (stocks) have a much higher payoff than bonds. Over a period of 20-30 years, the former will return at about 8% a year; the latter just 1%. One of the possible explanations is loss aversion: people don't like to see value decrease so they gravitate towards bonds, which are always increasing. Shermer uses loss aversion to explain why people tend to choose B:

A is waiting in line at a movie theater. When he gets to the ticket window, he is told that as he is the 100,000th customer of the theater, he has just won $100.

B is waiting in line at a different theater. The man in front of him wins $1,000 for being the 1-millionth customer of the theater. Mr. B wins $150.

Amazingly, most people said that they would prefer to be A. In other words, they would rather forgo $50 in order to alleviate the feeling of regret that comes with not winning the thousand bucks. Essentially, they were willing to pay $50 for regret therapy.

Another possible reason is the tendency for people to judge their wealth in relative and not absolute terms. I'd rather be wealthier than the people around me, not even more wealthier if it means others become richer than I. In the land of the blind, the one-eyed man is king. Research suggests a lot of people would rather be king than have depth perception.

The origins of loss aversion and relative wealth probably lie in evolutionary psychology. Economics should be particularly interested in this field; it can explain why people dislike free trade, feel economies are zero-sum, and romanticize the poorer but more familiar past.

HT: Brian Hollar

Political Rules

Paul Krugman calls them "Clinton rules," where everything a candidate says is distorted by the other side into a negative ad. Negative campaigning in general sickens Krugman and warns the DNC "...if history is any guide, if Mr. Obama wins the nomination, he will quickly find himself being subjected to Clinton rules. Democrats always do." (Hate Springs Eternal, February 11, 2008)

It's not clear which party engages in more negative campaigning, but I bet it has a lot more to do with the desperation of the campaign than its party. Despite what the electorate claims, negative campaigning works and is especially tempting in the political sphere where the runner-up is still a failure. There is so much to lose. Recall one of the most famous (and most negative) campaign ads in U.S. history, where Democrat Lyndon Johnson suggested Republican Barry Goldwater would be responsible for a nuclear war if he was elected. Mr. Krugman should read his own titles: hate truly does spring eternal.

Do You Want Morphine With That?

It's quite clear that as manufacturing jobs disappear, they are being replaced with service jobs. Really this is only a half-truth; professional and related occupations are increasing at the same rate as the service sector (17%) and each have about the same number of workers (just shy of five million).

Most people bemoan the growth of services. When they think of "service sector" they think of waiting tables and stocking shelves. And yes, in absolute terms most of the new jobs in the next ten years are likely to be in retail.

But the absolute numbers don't really matter; the growth rates do. Suppose we see 1000 jobs added in a high wage sector and 1000 added in a low wage sector. You might think the two are keeping in perfect step with each other. But suppose the former had 10,000 to begin with and the latter had 100,000. Now it's a 10% increase versus just 1%. Percents are much more useful because they show us the trend of employment. Is America heading to a high-wage service sector or a low-wage service sector. These projected numbers from the BLS (2006-2016) have the answer.

25% Health care and social assistance
23% Professional and business services
14% Financial activities
14% Leisure and hospitality
13% Other services
11% Educational services
10% Construction
9% Transportation and utilities
8% State and local government (except hospitals and education)
7% Information
5% Retail

Just because your most common exposure to the service sector is retail doesn't mean that's what is seeing the most growth. Guess we all won't work for Wal-Mart after all.

Focus on the Fundamentals

Of the Millennial generation, Michelle Conlin writes "They don't need an economics degree to understand that the middle class is squeezed." You can be sure of that, only because those who with such degrees know better.

Adjusting for fringe benefits and improving quality, people of all income levels are experiencing rising standards of living. Those that rely only on income data miss what those incomes can buy. The vast majority of products are cheaper, either in the form of lower prices or better quality. The evidence is all around us: Americans eat out more, retire earlier, own more cars, and send more kids to college than they did thirty years ago. They have iPods, Internet, laptops, cell phones, cable TV, DVDs, and eBay. More Americans own microwaves, multiple cars, dishwashers, color televisions, and air conditioning. Despite what movies like Office Space claim, working in a cubicle is cleaner, safer, and more pleasant than a factory floor. Health costs are increasing in part because we now have procedures that simply weren't available twenty or thirty years ago. Arnold Kling argues that a key problem with health care in the U.S. is that we have too much expertise, calling it a Crisis of Abundance.

Income data is certainly not nothing, but it's hardly enough to tell us what's really going on. Economies fluctuate, a reality people only seem to acknowledge when they does well. But the fundamentals of the economy are still good, so let's all take a breath and remember the trend is still overwhelmingly upward and the bad times are still brief and rare.

HT: Rhett Butler

Hillary's War on Health Care

In Lewiston, Maine today Sen. Clinton referred to a time when she used her influence to get an insurance company to pay for a claimant's health care. It shouldn't take a senator to get them to do this, she argued. She called for a cap on insurance premiums yet paradoxically emphasized the importance of preventive care. Sen. Clinton desperately needs a lesson in basic economics.

Any doctor will tell you people can engage in their own preventive care through every day activities: eating healthier, exercising more, quit smoking, having regular checkups. But each of these things require initiative on the part of the patient, not the doctor, not the insurance company. But if we make it cheaper for those with insurance to ignore preventive care (by capping premiums), they won't be as interested in it.

Yet the very companies Clinton demonizes have that incentive. Non-smokers get a better insurance deal than smokers. Those in better shape get a better deal. Companies already reward those who engage in preventive care because they know such people are cheaper to care for. Despite what the Senator suggests, these firms keep their promises and they pay up often. It doesn't take a senator to get them to keep their promises. It does, however, take one to get a company to go beyond their promises and pay for another's mistakes or bad luck. With all the politicians wanting to gut these firms, it's a wonder that anyone stays in this business at all.

Makes Cents

My little sister shared this bit from Snopes.com, the urban legend police, verifying the rumor that the cost of a penny exceeds its exchange value. A good example of how a monopoly-free coinage market would be more efficient than the Federal Mint? If pennies aren't worth the cost involved, people would just stop making them.

SAG Unfair!

So, first, members of the Writers' Guild of America strike. Then the Screen Actors' Guild orders all of its members to boycott the Golden Globe Awards to show support for them. Fashion bloggers all over the world bemoaned the loss: No pretty outfits to "ooh" and "ah" over. No heinous fashion crimes to gossip about. Nothing.

Now, there's rumor of a repeat with the Academy Awards. Solution? I think that the fashion and beauty industry should respond with their own strike! Revenge on the movie stars! Designers and stylists will protest all of the money lost over the last month or so.

Think about it: No free $5,000 shoes. No begging designers. No perfectly orchestrated ensembles. No perfectly done nails, makeup, and hair. No gushing fashion journalists. We'll watch as the SAG members attend next year's big events in last year's get-ups and self-applied dye jobs. Scary isn't it?

Most interesting sentence I've read today

From a book review on the Roman Empire:

The animals of Roman Italy slept in better buildings than the kings of post-Roman northern Europe.

Car of the Future?

I mentioned recently a $1 billion prized if you can "Achieve 150 miles per gallon of gasoline in a 3,000 lb. car, using EPA standards; without increasing the cost of a normal car more than 10%." I wonder if this guy knows about it. It looks like he is working for a different prize, although for a bit less money.

Non-Voters Are Still Citizens

As Super Tuesday draws near, commentators of all stripes agree that only voters get to complain. It's one of the stranger get-out-the-vote strategies: if you don't support one candidate, you're not allowed to point out any the flaws of the political system.

How does this work? If a non-voter protests government corruption, their facts are not falsified and their arguments are not rendered illogical. Are such commentators suggesting we ignore intelligent points simply because someone didn't side with a candidate? Perhaps they believe that the governance of the country is only the business of those who participate regardless of who fund it or the who is affected by it. Should all their rights be ignored, along with freedom of speech? It hardly seems ethical to demand that either people support a candidate or become a second-class citizen.

Protest is a right, not a privilege; it's to be maintained, not earned. One does not need to be part of the institution to note its flaws. Indeed, it is only from the outside where the most insidious failings can be found. In some ways non-voters should garner special attention. They are so disenchanted with the choices at hand, they will refuse to participate even in the face of those who paint silent disapproval as ignorance and irrelevance.

More Prizes

Via Arnold Kling, here are four billion dollar projects.

1. Develop a cure for breast cancer.

2. Develop a cure for diabetes.

3. Reduce greenhouse emissions from petroleum powered automobiles by 95% without increasing the cost of a normal car more than 5%.

4. Achieve 150 miles per gallon of gasoline in a 3,000 lb. car, using EPA standards; without increasing the cost of a normal car more than 10%.

Self-Interest Is the Secret to Growth

Paul Krugman correctly points out that the developing stimulus plan is hogwash, but for all the wrong reasons. The goal is not, as Krugman states, to increase consumer spending. That's easy; we can do that tomorrow. Simply ban all forms of investment. But everyone knows that won't be growth (thankfully).

Similarly, as Don Boudreaux explains, moving money around won't expand the economy either. You can't fill a pool by moving buckets of water from the deep end to the shallow end. You can't make society wealthier by taking from some and giving to others.

Economies grow from a rising living standard, a standard that betters as skill and productivity expand. Krugman quotes FDR: “We have always known that heedless self-interest was bad morals; we know now that it is bad economics.” But the opposite is true. Self-interest motives countless investors and entrepreneurs to find ways to increase our capacity to make things people want. Spending is a reward, not a means.

HT: Rhett Butler

Koch Classic

If you'll be on Mason campus on February 12 or March 19-20 you might want to hunt down Lea Krohn who'll be fielding questions concerning the Koch Associate Program.

I recommend stopping by not merely because she's an alum of my undergraduate almamater (Beloit College). Not merely because she is one of a handful of female classical liberals and is thus a wonder to behold. Not merely because she contacted me to request a promotion on this little blog. Not merely because she dropped the name of a mutual friend, (even though this friend works for a senator). No; most of all Koch programs are prestigious recognitions of excellence, emphasizing practical experience and valuable networking opportunities. Kcoh fellow go very far and it's worth taking a moment to find out if you have what it takes to be one.

Plus ca change, plus c'est la meme chose

Recently I just finished reading Anything for a Vote: Dirty Tricks, Cheap Shots, and October Surprises. The book goes through each presidential election in US history and focuses on how dirty each was. Each election gets 2-6 pages or so. Here are some of the highlights:

In 1800 Jefferson’s people called Adams “a hideous hermaphroditical character which has neither the force and firmness of a man, nor the gentleness and sensibility of a woman.” Adam’s supporters responded with “Jefferson is a mean-spirited low-lived fellow, the son of a half-breed Indian squaw, sired by a Virginia mulatto father.” They also spread rumors that Jefferson was dead.

In 1828 John Quincy Adam’s supports taunted Andrew Jackson in the hopes that he would challenge someone to a duel. Jackson supporters spread rumors that Adams had offered his wife’s maid to the czar as a concubine.

Davy Crockett in 1836 said that “Martin Van Buren is laced up in corsets, such as women in a town wear, and if possible tighter than the best of them. It would be difficult to say from his personal appearance, whether he was a man or a woman, but for his large red and gray whiskers.”

One of the worst elections ever was 1876. Tilden’s supports said that Hays shot and wounded his mother “in a fit of insanity.” Hays people claimed Tilden got syphilis from an Irish whore which made him susceptible to blackmail.

For the 1896 election the New York Times published an article called “Is Mr. Bryan Crazy?” It stated that if Bryan was elected “there would be a madman in the White House.” Two days later another article appeared that said Bryan suffered from megalomania, paranoia querulent (complaining too much), and querulent logorrhea (talking about complaining too much).

It was an enjoyable read, and I learned a lot not only about dirty political tactics but American history as well. I recommend this book, especially if you think that politics has never been worse than it is today.

Contracts Are Not Jails

About five months ago, I signed a nine-month lease with my landlord. Since that time his relatively quiet one-and-a-half-year-old has morphed into a louder two-year-old, my landlord got an additional dog, the wiring in the house is now in noticeably poor shape, and my evolving requirements have exceeded the small space I live in. These are all relatively slight annoyances, but enough to make me want to move. But I have to wait until May, when my lease runs out. No big deal. I see myself in an unfortunate situation of partly my own doing. But not according to Bob Sullivan because I'm "in jail."

For the record, jail is where you go when people take you by force and hold you there. You do not volunteer to go there. Yet Sullivan paradoxically announces that Americans are in "cell phone jail" because they face stiff penalties if they end their contract early. This phrase is utter nonsense. Contracts are not jails, but promises both parties agree to. In this case, the customer loses flexibility and gains lower prices or peace of mind (not having to keep track of your minutes is valuable to many).

Granted, some people later regret their decision. Cell phone companies change prices. Coverage wasn't what was hoped for. For people to pay for something they don't want is undesirable. But when the contract (usually two years) is up, people can switch at no charge. Most don't. Now if many people made a stink about their provider and switched en masse we'd see lower fees, better coverage, and other improvements Sullivan claims can't exist because Americans are prisoners. But people are generally happy with their service, a fact we forget in the heat of the moment because we focus on the few times it doesn't work and not how often it does.

If we were truly prisoners, why would any cell phone company try to please us at all? Why not just cut costs down to nothing, sell people toy phones, and charge them $1,000 a month? It's because we're customers who tie our own hands for a time but will refuse to do it again the moment we feel we are truly "jailed."

HT: Jason Youngberg

The Ten Really Important Things To Remember

Friday on Real Time, Bill Maher argued the Ten Commandments demonstrate the backwardness of religion and have little to do with our time. Most of them are stupid, referring to how great God is, and others are simply obsolete.

But those first five are really about making the second five legitimate. This is the word of the only God (a word your parents are likely to share), and he's serious about being the only God. You better not pay attention to anyone who says some other deity wants to add, subtract or modify the laws. And they're good laws. I'm not a religious person, but it's easy to see the advantages in taking these things to heart. The sentiment, the big picture, behind the second five are things all cultures can embrace:

-Don't murder.
-Don't commit adultery (or, generally, "keep your promises")
-Don't steal.
-Don't lie about your neighbor (or, generally, don't lie)
-Don't covet your neighbor's wife/house (or, don't desire stuff to the point that it hurts others)

True, these are not perfect and could use some updating. But the essential elements of the sanctity of people, property, and promises are there. Religion isn't mindless and the people of the past weren't stupid. Just because it's about God doesn't make it worthless.

When Maps Meet Encylopedias

Google Maps is a great resource for finding your way around the city, especially in an area you've never been to. The only problem is everything looks so unrecognizable from the satellite and it gets time consuming to pin point every needed locale. Google Maps Street View is nice, but only available in some parts of a few cities.

Enter Wikimapia which combines all the great aspects of Wikipedia with all those of Google Maps. Everything on Wikimapia looks like what you would see on any satellite except the screen is covered with a cornucopia of boxes. Hover over a box, and it'll tell you what you're looking at. Click on it and a little window will pop up, giving you a short description. There are ads, done, of course, by Google.

Only a year and a half old, users have tagged over five million sites. Few things are perhaps as good as capturing Hayek's "man on the street" as this.

Green Greed

In our own way, we are all environmentalists. Rare is the person who desires to see animals go extinct or bulldozes old growth forests for kicks. The question is not should we embolden the natural environment but how.

Enter such phrases as "free market environmentalism." Economic development and environmental protection are not mutually exclusive, though pundits often paint them as such. Polluting less can save a company money; all pollution is something the company bought, reformed, and then throws away. A power plant in my hometown sells its excess heat to an adjacent Alcoa plant instead of the Mississippi River. The plant is happy, Alcoa's happy, and the fish are happy.

Economic growth comes from fulfilling people's desires and that includes environmental concerns. Harry Smith at CBS writes to inform us of a car that runs on batteries instead of the internal combustion engine. Ok, it may not get rid of pollution if the homes are powered by coal plants or the supply chain to make the battery yields a net loss. But it does demonstrate that firms are willing to invest millions in these new technologies because they know it will attract paying customers. To paraphrase a great economist, it is not from the benevolence of the builder, the banker, and the boss that we expect a cleaner environment, but from their regard to their own self interest.

Safety Regulations Can Be Dangerous

People often scoff when I argue that more laws and standards reduce innovation. Scoffers probably can't think of an example of what wasn't created because of those restrictions. Enter the Tata Nano, a $2,500 unveiled in India yesterday. In a country where the next cheapest car runs about four times as much, the Nano has a lot of potential to give mobility (and opportunity) to a lot of people.

But don't expect the US (or Europe) to benefit from mobility--the Nano won't meet the government's safety standards. We are forced to favor safety over price, or get nothing and the poorest are hurt most of all. In a country where it's hard to go anywhere without a car, those who need the most opportunities find their job choices severely curtailed.

Some might say we don't want less safe (but cheap) cars, but even that is not obvious. Recall that in the wake of Hurricane Katrina, where people lost their lives because they has no way to escape New Orleans, the more expensive car was the more dangerous one.

Demand Curves Still Slope Down

Paul Krugman argues (January 7) that increasing taxes on the wealthy will not hinder the slowing US economy. It's a strange argument considering the wealthy invest much more and this investment is a key input into how economies grow. If you tax people more, especially on investment, they will be less likely to invest. Krugman cites the high growth rates in the Clinton era but it isn't, as he implies, due to high taxes. The plethora of possibilities was due to the dotcom boom. Krugman is mistaking coincidence for logic.

Of course if you do want to play this game, Herbert Hoover sharply raised taxes in 1932 and it didn't fix the problem.

The Tyranny of Oil?

During his Iowa Caucus victory speech, Barack Obama promised (among many, many other things) an end to the "tyranny of oil." Mr. Obama must be confused--Americans voluntarily buy countless barrels every day. We habitually downplay substitutes, opting to live far from city centers, shunning buses, and using candles primarily for romance. Claiming we are under a tyranny of the very thing we choose to buy is like accusing Google, McDonald's, and Nintendo of being dictators.

Mr. Obama ironically said this in Iowa, where farmers collect taxpayer money to grow corn. This is money taken by force and handed out to a select few, offering no clear benefit to society. Ethanol, not oil, is the closer autocrat.

The Separation of School and State

Okay, it's getting down to the worse time of year for me. It's that time when every California state university and college student is pressured to register to vote. And those doing the pressuring make no bones about putting in a good word for their own favorites.

Back when Governor Kennedy (aka, the "Governator") was running, I was hounded by campus advocates collecting Social Security numbers - in the form of voting registrations. One rep actually told my friends and me that we needed to register "so that you can vote 'No' on the recall and for Bustamonte for governor"!!! So, I need to be told how to vote? By a campus rep?

A year later, during a grad student orientation, some rep from the Office of the Dean of Graduate Studies actually told the non-California residents that they needed to vote in California to get residency...a blatant lie! She also hinted that their votes were needed to it to avoid a repeat of the 2000 Presidential election. She failed to mention that, regardless of what these students did, California's electoral votes were going to go to the Democratic candidate. All she did was encourage students from borderline states to throw their votes away!

Why pressure college students to vote? Yes, they're underrepresented in the voting population, but isn't that their business? Why have links on the school website? Why the pop-up ads? Why let activists take up precious classroom time to encourage full-grown adults to do something that they obviously would have done if they cared about it? I call for the separation of school and state! Leave the on-campus recruiting to independent groups and their sidewalk booths and rallies. At least, they're expected to be partisan.